Scientific Beta

Benefits and Pensions Monitor: "New forms of alternative-weighted equity indices run the risk of seriously underperforming traditional cap-weighted indices, says the EDHEC-Risk Institute. Its research paper ‘Diversifying the Diversifiers and Tracking the Tracking Error: Outperforming Cap-Weighted Indices with Limited Risk of Underperformance,’ shows that the main alternative indices on the market, while superior performers over the long term, have considerable relative drawdowns with regard to their cap-weighted counterparts."

Benefits and Pensions Monitor 31/08/2012

"(...) New forms of alternative-weighted equity indices run the risk of seriously underperforming traditional cap-weighted indices, says the EDHEC-Risk Institute. Its research paper ‘Diversifying the Diversifiers and Tracking the Tracking Error: Outperforming Cap-Weighted Indices with Limited Risk of Underperformance,’ shows that the main alternative indices on the market, while superior performers over the long term, have considerable relative drawdowns with regard to their cap-weighted counterparts. These drawdowns can be long (more than two years) and significant (more than 13 per cent). The research identifies two major sources of risk. One is risks that stem from a more pronounced ‘structural’ exposure to risk factors, which, through their associated premia, lead to outperformance over cap-weighted indices over the long term, but which, in certain conditions, can negatively affect the performance of these new indices. The other is that every weighting scheme, whether it is qualitative or quantitative, corresponds to a choice of model and, therefore, contains model risk. On the basis of this, it recommends diversifying beta investment, monitoring explicit information on tracking error and extreme tracking error, and managing this constraint explicitly. (...)"